A drop in conventional industry spending in anticipation of a new royalty plan, rising costs and the strong Canadian dollar all present challenges to Alberta's natural gas business, according to Houston-based Ziff Energy Group.

Gas drilling has become dominant in Alberta over the past decade, with more than two gas wells drilled for each oil well last year, according to Ziff CEO Paul Ziff. But higher royalty rates on new and existing oil and gas projects, recommended last year by Alberta's Royalty Review Panel (see NGI, Sept. 24, 2007), are making things harder than necessary for the industry.

"Based on the much lower price for natural gas than oil and today's higher drilling and operating costs, the new royalties on natural gas production are coming at a lousy time -- and are contributing to a sharp drop in current and future gas drilling activity and a drop in employment for the related services sector, which is spread all across Alberta," Ziff said.

The government-appointed Royalty Review Panel said the province could collect C$2 billion annually by increasing the government's total taxes and royalties on the natural gas sector to 63% from 58%, increasing taxes and revenues on the oil sands sector to 64% from 47% and increasing taxes and revenues on the conventional oil sector to 49% from 44%. The report also recommended placing a 1% severance tax on bitumen when it is selling as low as C$40/bbl, with the tax rising as high as 9% if prices reach C$120/bbl. The panel recommended that Alberta's 1% base royalty rate, which is applied to oil sands projects during the pre-payout period, remain in place.

The recommendations, based on "erroneous information (provided by an American consulting firm) and incomplete cost models," have led to a sharp drop in conventional industry spending in the province, Ziff said.

Canada's largest gas producer, EnCana Corp., threatened to reduce its 2008 capital investment in Alberta by 30-40%, or US$1 billion, if the recommendations were adopted (see NGI, Oct. 1, 2007). Days later Calgary-based Crescent Point Energy Trust followed suit, announcing that it would direct all of its 2008 capital budget to exploration and production activities in neighboring Saskatchewan (see NGI, Oct. 8, 2007). And earlier this month Apache Corp. said it planned to pull back on its spending in Alberta (see NGI, Feb. 11a). Activity in the province "will be limited and refocused on shallow gas opportunities" that were not affected by the royalty changes, and activity is set to increase at the Ootla shale play in British Columbia, Apache said.

In addition to concerns about Alberta's royalty rate plans, industry in the province has seen a dramatic escalation in the cost to find new gas reserves. The full-cycle gas cost -- including expenses for facilities, land and seismic -- rose from C$1.50/Mcf in 1995 to C$4.70 in 2006. Faced with those costs, higher royalty rates and taxes, "the price of natural gas is not high enough to justify average new gas exploration," Ziff said.

Meanwhile, industry spending in neighboring Saskatchewan and British Columbia is booming and U.S. gas drilling continues to increase, thanks to lower costs and royalties, Ziff said. Those provinces, along with Montana and Colorado, are actively courting Alberta gas producers to shift their focus, and some are going, Ziff said. Saskatchewan raised a record C$197 million during its sale of Crown petroleum and natural gas rights for February (see related story). A survey of energy industry experts, issued in December by The Fraser Institute, indicated that potential investors rated Saskatchewan as more favorable than Alberta (see NGI, Dec. 17, 2007).

Deep gas, in Western and Northwestern Alberta, and shallow and coalbed methane in Central and Southeast Alberta, have been most impacted, Ziff said.

"Unless the proposed royalty program is revised, conventional gas activity will decline sharply, creating a 'made in Alberta' recession in 2008 (outside of the oil sands)," Ziff said. "The increase in provincial net revenues of $1.4 billion in 2009 is a 'house of cards' ready to tumble."

Changes to Alberta's royalty plan are not due to go into effect until 2009 and the final plan may end up being quite different than that recommended by the Royalty Review Panel. After Conservative Premier Ed Stelmach called a provincial election for March 3, royalties and faltering natural gas drilling emerged as an issue, with national political leaders offering a variety of alternatives and indicating that the issue may be reopened (see NGI, Feb. 11b).

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